TAXATION  OF 
PUBLIC  SERVICE  CORPORATIONS 


BY 
CARL   C.    PLEHN 

PROFESSOR   OF   FINANCE   AND   STATISTICS,    ETC. 


REPRINTED  FROM  THE  ADDRESSES  AND  PROCEEDINGS  OF  THE 

NATIONAL  CONFERENCE  ON  STATE  AND  LOCAL  TAXATION 

HELD  AT  COLUMBUS,  OHIO,  Nov.  12-15,  1907 


NATIONAL   TAX   ASSOCIATION 
COLUMBUS 


TAXATION  OF 
PUBLIC  SERVICE  CORPORATIONS 


BY 
CARL   C.    PLEHN 

PROFESSOR    OF    FINANCE   AND    STATISTICS,    ETC. 


REPRINTED  FROM  THE  ADDRESSES  AND  PROCEEDINGS  OF  THE 

NATIONAL  CONFERENCE  ON  STATE  AND  LOCAL  TAXATION 

HELD  AT  COLUMBUS,  OHIO,  Nov.  12-15,  1907 


NATIONAL  TAX  ASSOCIATION 
COLUMBUS 


TAXATION  OF  PUBLIC  SERVICE  CORPORATIONS 

BY  CARL  C.  PLEHN 

Professor  of  Finance  and  Statistics,  University  of  California, 
Berkeley,  Cal. 

THERE  is  a  marked  tendency  in  the  United  States  to  apply  to 
corporations  methods  of  taxation  different  from  those  applied 
to  individuals.  This  tendency  is  most  pronounced  in  those 
States  whose  economic  development  is  most  advanced.  It 
arises  mainly  from  the  inadequacy  of  our  old  taxes  to  reach  the 
tax-paying  capacity  of  the  large  corporation.  But  it  seems 
also  to  be  closely  related  to  certain  recent  developments  in 
the  social  and  economic  philosophy  of  the  times,  especially 
to  those  philosophical  tenets  which  concern  the  social  control 
of  the  larger  industrial  enterprises.  Government  regulation 
of  rates,  the  opposition  to  monopolistic  combinations,  the  pro- 
hibition of  discrimination,  the  popular  condemnation  of  stock 
watering  and  similar  abuses  or  manipulations  of  corporation 
capital,  the  demand  for  publicity  of  accounts,  are  all  the  out- 
come of  a  trend  of  thought  which  has  a  deal  to  do  with  shaping 
our  tax  laws. 

This  essay  is,  however,  not  concerned  with  these  larger 
questions  of  social  control,  but  will  be  an  attempt,  as  if  made  on 
the  part  of  a  fiscal  officer,  to  answer  the  practical  question, 
"  How  can  the  government  most  easily  and  surely  obtain  from 
those  larger  industrial  enterprises  now  for  the  most  part  con- 
ducted by  corporations  a  fair  contribution  in  the  way  of  taxes  ?" 

The  legal  and  economic  right  of  government  to  apply  to 
corporations  a  method  of  taxation  different  from  that  applied 
to  natural  persons  rests  on  the  obvious  fact  that  the  corporation 
is  a  special  creation  of  government,  and  the  natural  persons 
associating  together  to  form  the  artificial  person  enjoy  there- 
from certain  advantages  not  enjoyed  by  those  not  so  specially 
privileged.  It  is  clearly  within  the  powers  of  the  government 

635 

345S48 


636  STATE   AND   LOCAL   TAXATION 

- 

when  it  creates  or  continues  these  special  privileges  to  place 
upon  them  such  limitations  as  it  sees  fit.  It  may  consequently 
tax  them  as  it  sees  fit.  Ordinarily  no  fiscal  officer  would  assume 
that  this  power  to  tax  the  special  privileges  enjoyed  by  cor- 
poration could  be  exercised  to  such  an  extent  as  to  destroy 
the  privileges.  But  it  is  certainly  within  the  discretion  of  the 
legislative  authority  to  exercise  the  power  of  taxation  even 
to  that  extent. 

The  movement  toward  special  forms  of  taxation  for  corpora- 
tions in  the  United  States  is  comparatively  recent.  If  we 
except  Pennsylvania  and  Massachusetts,  which  were  the  earliest 
to  establish  a  clear  differentiation  between  the  taxation  of 
corporations  and  that  of  individuals,  and  New  York,  which  has 
been  some  twenty-five  years  evolving  such  a  system,  and  if 
we  regard  the  "specific"  taxes  of  Michigan  and  her  neighbors 
as  sporadic  or  accidental  exceptions,  we  may  assert  that  the 
whole  movement  has  taken  place  within  the  last  twelve  years. 
While  it  is  still  true  that  the  great  majority  of  our  States  to-day 
depend  primarily  on  the  general  property  tax  for  the  taxation 
of  corporations  and  individuals  alike,  yet  of  the  fifty-one 
States  and  territories  in  the  Union,  fourteen,  namely,  Connecti- 
cut, Delaware,  District  of  Columbia,  Maine,  Maryland,  Massa- 
chusetts, Michigan,  Minnesota,  New  Jersey,  New  York,  Penn- 
sylvania, Virginia,  West  Virginia  and  Wisconsin,  have  already 
adopted  radically  distinct  methods  for  taxing  corporations; 
of  the  remainder  the  great  majority  have  at  least  started  along 
the  road  already  traveled  by  the  fourteen  leaders;  only  six, 
namely,  Alabama,  Colorado,  Louisiana,  Mississippi,  Montana 
and  Nebraska,  can  be  said  not  to  have  passed  the  first  mile- 
post,  and  of  these  six,  two  are  now  actively  inquiring  the  way. 
In  short,  there  are  but  four  commonwealths  which  have  not 
felt  the  sway  of  the  new  ideas. 

An  analysis  of  the  methods  of  taxation  applied  to  corporations 
in  the  more  advanced  States  shows  a  more  or  less  general 
recognition  of  four  different  kinds  of  special  privileges  as  the 
bases  of  special  taxes  or  special  methods  of  taxation.  The  first 
of  these  is  the  right  to  become  a  corporation.  This  is  everywhere 
subject  to  fees  payable  at  the  time  of  incorporation  which  vary 
in  amount  from  the  mere  compensation  for  official  labor  in 


TAXATION   OF   PUBLIC  SERVICE   CORPORATIONS     637 

issuing  papers  to  a  sum  which  constitutes  of  itself  a  good  stiff 
tax.  The  second  of  these  is  the  right  to  continue  to  be  a  cor- 
poration. This  is,  in  many  of  our  States,  now  subject  to  the 
payment  of  an  annual  fee  or  license.  This  tax  is  among  the 
more  recent  additions  to  our  list  of  corporation  taxes.  It 
serves,  besides  its  undoubted  revenue-yielding  function,  to 
secure  a  current  record  of  active  corporations  and  to  eliminate 
dead  companies  from  the  rolls.  As  the  rates  are  usually 
graduated  according  to  capital,  it  also  tends  to  prevent  over- 
capitalization. The  third  special  privilege  is  the  right  to  do 
business  in  a  way  not  granted  to  private  individuals,  or  to  do 
some  particular  business  not  ordinarily  permitted  to  private 
individuals.  The  States  of  the  old  South  through  their  highly 
elaborated  system  of  license  taxes  have  developed  the  taxation 
of  this  special  privilege  more  distinctly  and  in  a  more  easily 
recognizable  form  than  has  yet  been  possible  in  the  Northern 
States.  But  for  special  groups,  like  banks  and  insurance 
companies,  this  is  a  very  common  subject  of  special  taxation. 
In  some  cases  the  taxation  of  this  privilege  has  been  so  far 
extended  as  to  cover  elements  akin  to  good  will  which  are  not 
taxed  ordinarily  when  enjoyed  by  private  individuals. 

The  fourth  or  last  group  of  special  privileges  enjoyed  by 
corporations  which  have  been  made  the  subject  of  special 
methods  of  taxation  are  the  special  franchises  enjoyed  almost 
exclusively  by  "public  service  corporations."  These  are 
privileges  the  enjoyment  of  which  is  never  conferred  except 
explicitly,  and  are  distinctly  in  addition  to  the  ordinary  cor- 
porate privileges.  In  most  cases  they  involve  a  partial  dele- 
gation of  government  powers.  They  almost  invariably  result 
in  monopoly  or  form  the  basis  for  monopoly,  and  are  often 
extremely  valuable.  It  is  furthermore  usually  true  of  them 
that  they  have  grown  in  value  as  time  passed  far  more  rapidly 
than  was  anticipated  when  they  were  granted. 

There  have  been  four  different  ways  used  in  the  United 
States  for  reaching  this  fourth  class  of  special  privileges  for 
purposes  of  taxation.  These  are:  (1)  the  property  tax;  (2) 
the  net  earnings  tax ;  (3)  the  gross  earnings  tax ;  (4)  the  license 
tax.  The  oldest  and  still  the  most  prevalent  is  to  treat  these 
privileges  as  property  and  include  them  in  the  valuation  of  the 


638  STATE   AND   LOCAL   TAXATION 

taxable  property.  The  valuation  may  be  arrived  at  in  two 
ways:  (1)  by  valuing  the  tangible  property  and  then  adding 
an  amount  equal  to  the  difference  between  that  and  the  value 
of  the  stock  (including  bonds).  This  difference  is  called  the 
"corporate  excess"  in  Illinois  and  other  States,  the  " value  of 
the  franchise"  in  California  and  others,  or  more  generally 
the  "value  of  the  intangible  property";  or  (2)  by  ascertaining 
the  earnings  and  capitalizing  them,  thus  obtaining  the  value 
of  the  aggregate  properties,  and  then  proceeding  as  before  by 
deducting  from  this  aggregate  the  appraised  value  of  the 
tangible  property,  thus  obtaining  the  value  of  the  corporate 
excess  "  of  the  intangible  property." 

The  taxation  of  these  special  privileges  as  property  is  a  plan 
which  has  many  able  advocates.  The  fact  that  two  States, 
Michigan  and  Wisconsin,  which  had  another  system  originally, 
adopted  this  plan  after  prolonged  discussion  and  agitation 
has  given  it  considerable  recent  prestige.  But  it  is  open  to 
several  very  pronounced  and  serious  objections.  In  the  first 
place  this  system  requires  that  the  board,  commission  or  officer 
making  the  valuation  shall  be  vested  with  discretionary  powers 
which  cannot  be  characterized  as  other  than  arbitrary.  These 
powers  must  be  so  large  that  if  not  exercised  with  due  reserve, 
they  may  be  destructive.  Vesting  any  elective  or  even  ap- 
pointive officers  with  such  power  in  regard  to  public  service 
corporations  has  the  practical  effect  of  dragging  those  corpora- 
tions into  politics  for  the  purpose  of  controlling  such  officers. 
Even  if  the  price  of  reduced  taxes,  often  amounting  to  many 
hundreds  of  thousands  of  dollars  per  annum,  be  not  lure  enough 
to  tempt  the  corporations  to  struggle  for  the  control  of  these 
boards,  there  is  still  the  prod  of  necessity  to  prevent  the  election 
or  appointment  of  a  hostile  board  or  official.  Experience  has 
shown  that  while  it  is  possible  for  a  few  years,  as  in  Michigan 
and  Wisconsin,  to  establish  reasonably  public  spirited  boards 
of  assessment,  yet  that  after  a  time  these  boards  usually  become, 
if  not  subservient  to  the  corporate  interests,  so  inert  as  to  be 
ineffective  for  the  protection  of  public  interests. 

Directly  connected  with  this  danger  is  the  tendency,  inevitable 
if  judged  by  all  historical  instances,  for  the  assessment,  when 
made  on  an  ad  valorem  property  basis,  to  crystallize  and  become 


TAXATION   OF  PUBLIC  SERVICE   CORPORATIONS     639 

rigid.  One  has  only  to  compare  the  growth  of  the  assessment 
of  railroads  (the  most  easily  available  data)  in  those  States  which 
have  used  this  system  for  any  length  of  time  with  the  growth 
in  the  valuations  placed  on  other  property,  or,  for  a  more  tell^- 
ing  contrast,  with  the  growth  of  the  gross  and  net  income  of 
the  same  railroads,  to  be  convinced  of  the  strength  of  this 
tendency.  Any  board,  whether  subservient  to  the  corpora- 
tions or  not,  after  it  has  once  made  the  extensive  investigations 
necessary  to  fix  a  valuation,  say,  on  railroad  franchises,  is  most 
naturally  prone  to  regard  that  as  final  and  conclusive  for  some 
years  to  come.  It  may  make  additions  to  the  assessment  for 
improvements  and  for  new  property  acquired,  but  it  is  not  apt  to 
revise  its  valuation  of  the  original  property.  Only  when  such  a 
board  is  sturdily  enforcing  some  other  system  of  taxation,  under 
the  guise  of  a  property  tax,  does  this  tendency  remain  in  abeyance. 
That  so  many  States  still  rely  on  the  property  tax  for  this 
purpose  is  explained :  first,  by  the  fatuous  confidence  of  the 
American  people  in  the  all  sufficiency  of  that  tax  in  all  pos- 
sible contingencies  (a  confidence  ill  sustained  by  experience) ; 
second,  by  a  certain  confusion  of  thought,  namely,  that  "  equal 
taxation"  can  be  attained  only  by  applying  the  same  form 
of  taxation  to  all  subjects,  irrespective  of  differences  in  their 
character;  and  thirdly  and  lastly,  by  a  misunderstanding  of 
the  exact  scope  of  those  constitutional  provisions  which  safe- 
guard interstate  commerce.  Of  the  first  of  these  stum- 
bling blocks  it  is  sufficient  to  say  that  the  present  leaders  of 
American  political  thought  are  unanimous  in  their  view  that 
the  property  tax  is  inadequate  to  reach  all  the  forms  of  tax- 
paying  ability  which  modern  civilization  presents.  The  noto- 
rious failure  of  this  tax  to  reach  personal  property,  for  example, 
has  become  a  favorite  subject  even  for  schoolboy  debates  the 
country  over.  On  the  second  point  one  has  only  to  attempt 
to  fathom  the  meaning  of  the  popular  slogans  used  in  any  one 
of  the  recent  tax-reform  movements  to  be  satisfied  that  in  the 
popular  mind  " equal  taxation"  means  merely  "taxation  by 
the  same  method";  as  though  one  could  justly  tax  a  printing 
press,  which  runs  365  days  of  24  hours  each  per  annum,  on  the 
same  basis,  namely,  that  of  cost  of  construction,  as  a  hay  press, 
which  runs  only  30  days  of  12  hours  each  per  annum. 


640  STATE   AND   LOCAL   TAXATION 

Shallow  as  are  in  point  of  fact  the  first  two  of  the  above- 
named  current  objections  to  any  departure  from  the  general 
property  tax  as  applied  to  public  service  corporations,  the 
third  is  merely  fallacious,  and  rests  upon  ignorance  of  the 
principles  which  guide  the  Supreme  Court.  Unless  there  is 
a  deliberate  attempt  to  limit  by  means  of  taxation  the  free 
interchange  of  products  between  the  several  States,  the  Supreme 
Court  of  the  United  States  has  never  once  interfered  with  the 
States  as  to  the  choice  of  the  form  of  taxation  for  corporations 
engaged  in  interstate  traffic.  But  on  account  of  the  awe  in 
which  our  Constitution  is  held,  ignorance  on  this  point  is  very 
potent.  A  few  years  ago  Canada  sent  a  commission  to  this 
country  to  investigate  the  methods  in  vogue  for  the  taxation 
of  railroads.  That  commission  rendered  a  report  which  for 
ability  and  obvious  evidence  of  diligence  is  not  easily  surpassed 
among  public  documents  dealing  with  taxation.  The  clear 
vision  of  these  commissioners  showed  them  the  fallacy  of  the 
first  two  points  above  referred  to,  but  so  current,  even  among 
recognized  authorities  and  among  our  leading  attorneys  with 
whom  the  Canadians  conferred,  was  the  third  error  that  this 
sagacious  commission  carried  away  the  impression  that  any 
method  of  taxation  other  than  the  property  tax  was  uncon- 
stitutional in  the  United  States  as  applied  to  corporations  doing 
an  interstate  business.  Yet  in  the  face  of  this  current  legal 
view  Justice  Holmes,  in  voicing  a  unanimous  decision  of  the 
Supreme  Court  of  the  United  States,  a  decision  in  which  all 
the  wisdom  of  that  court  on  this  point  for  a  century  is  reviewed 
and  summarized,  brushes  aside  a  long  argument  with  the  curt 
statement,  "We  need  say  but  a  word  in  answer  to  the  sug- 
gestion (he  does  not  dignify  it  as  an  ' objection')  that  this  tax 
(a  tax  based  on  gross  earnings)  is  an  unconstitutional  inter- 
ference with  interstate  commerce."  The  same  court  had 
previously  said  in  regard  to  a  tax  on  the  property  and  franchises 
of  a  corporation  engaged  in  interstate  commerce,  the  tax  being 
based  solely  on  gross  earnings,  "  that  a  tax  of  this  character  is' 
within  the  power  of  the  State  to  levy,  there  can  be  no  question.'7 
(Maine  vs.  Grand  Trunk  Ry.  Co.,  142  U.  S.  217.) 

If  we  reject  the  property  tax  on  the  ground  of  its  inade- 
quacy when  applied  to  public  service  corporations,   we  are 


TAXATION  OF  PUBLIC   SERVICE   CORPORATIONS     641 

apparently  confined  to  a  choice  between  net  earnings  and 
gross  earnings  as  a  basis  for  taxation.  Taxation  according 
to  net  earnings  has  some  very  able  advocates,  who  have  built 
in  its  defense  a  very  strong  argument.  If  we  turn*  away  from 
property  as  a  basis,  it  seems  natural  to  turn  first  to  net  earnings 
as  that  which  gives  the  property  its  value.  When,  however, 
any  fiscal  officer  tries  to  devise  a  net  earnings  tax  which  will 
work  with  some  degree  of  justice  and  still  yield  the  necessary 
revenue,  he  finds  himself  confronted  with  difficulties  even 
greater  than  when  he  tries  to  make  a  property  tax  effective. 
By  long  experience  our  law  makers  and  our  officials  have  ac- 
quired a  somewhat  definite  idea  of  what  constitutes  property 
and  of  how  to  ascertain  its  value.  But  experience  offers  no 
such  clew  to  what  is  by  nature  a  "net"  item  in,  say,  a  railroad 
account.  The  placing  of  any  item  as  "  net"  is  largely  a  matter 
of  bookkeeping,  and  may  be  changed  in  a  day  by  a  vote  of  the 
directors  or  even  by  the  instructions  of  an  auditing  officer. 
If  taxes  are  to  be  based  on  net  earnings,  the  government  must 
not  only  supervise  the  bookkeeping,  but  prescribe  its  forms 
and  methods,  and  for  adequate  protection  it  would  have  to 
dictate  the  character,  if  not  the  amount,  of  all  expenses  that 
could  be  deducted.  That  means  that  the  cost  of  enforcing 
and  collecting  a  net  earnings  tax  would  be  well-nigh  prohibi- 
tive. Furthermore,  the  rates  would  have  to  be  so  high  that 
the  temptation  to  enter  politics  for  the  sake  of  modifying 
those  rates  or  the  definition  of  "  net"  earnings  would  be  greater 
than  the  public  service  corporations  could  be  expected  to 
resist.  An  arithmetical  example  will  make  this  clear.  Our 
railroads  count,  on  the  average,  about  36  per  cent  of  their 
total  earnings  as  net.  Assume  for  the  moment  that  1  per 
cent  on  the  full  cash  value  of  the  property  is  a  fair  tax  and 
that  6  per  cent  is  the  rate  at  which  we  would  capitalize  earn- 
ings in  determining  the  value  of  the  property.  Then  for  every 
$100  of  gross  earnings  we  should  have  $600  of  capital  and  the 
fair  tax  would  be  $6. ^ This  is  16  J  per  cent  of  the  net  earnings,  - 
a  tax  rate  so  high  as  to  put  an  enormous  premium  on  manipu- 
lation of  accounts,  and  to  hold  out  a  glittering  reward  for  the 
political  control  of  the  taxing  authorities.  It  would  seem 
then  that  the  practical  difficulties  in  the  way  of  administering 
2x 


642  STATE    AND    LOCAL   TAXATION 

a  net  earnings  tax,  namely,  expense,  uncertainty,  danger  of 
political  interference,  and   probable  evasion  and  inequalities, 
^are  prohibitive. 

A  gross  earnings  tax  at  a  fixed  rate  for  each  of  the  different 
classes  of  public  service  corporations  seems,  therefore,  the  only 
recourse.  The  objection  to  this  may  be  stated  first:  such 
a  tax  may  not  be  absolutely  equitable  between  the  different 
companies  within  a  class  when  measured  either  by  property 
value  or  by  net  earnings.  There  may  be  a  railroad,  for  example, 
whose  net  earnings  are  far  above  the  36  per  cent  average, 
which  would  apparently  gain  by  such  a  tax,  or,  vice  versa, 
one  whose  proportion  of  net  earnings  is  low,  which  might,  per- 
chance, suffer.  Forceful  as  this  objection  may  seem  when 
first  stated,  it  has  been  found  to  have  comparatively  little 
weight  when  investigated  practically.  The  Canadian  Com- 
mission, to  which  reference  has  already  been  made,  ascertained 
by  a  careful  study  of  every  road  in  Ontario  that  none  would 
be  really  injured  and  none  materially  advantaged  road  against 
road  by  such  a  tax.  The  recent  California  Commission,  after 
investigating  in  a  most  thorough  fashion  every  railroad  in 
that  State  which  might  be  affected,  including  roads  operated 
under  conditions  almost  as  varied  as  imagination  can  suggest, 
found  that  such  a  tax  would  be  very  nearly  equitable  for  every 
road,  with  the  possible  exception  of  one.  That  one  was  a 
small  narrow-gauge  road  operated  in  connection  with  a  steam- 
ship and  lumber  company  in  such  a  way  that  the  accounts  of 
the  three  departments  were  so  inextricably  intertangled  that 
the  net  earnings  were  not  easily  distinguishable  so  that  the 
fact  that  it  was  an  exception  was  a  matter  of  grave  doubt. 

The  economic  explanation  of  this  apparent  anomaly  is  prob- 
ably to  be  found  in  the  actual  outworking  of  the  long-recog- 
nized principle  that  "  the  rate  of  profit  on  capital  in  all  employ- 
ments tends  to  an  equality."  (Mill,  "  Principles  of  Political 
Economy/'  Book  II,  Chapter  XV,  Section  4.)  It  is  important 
in  this  connection  to  recall  to  mind  that  public  service  corpora- 
tions are  industrial  or  capitalistic  monopolies,  and  that  as 
monopolies  they  cannot  shift  a  uniform  gross  earnings  tax. 
Furthermore,  no  proportional  gross  earnings  tax  can  change 
in  any  way  the  point  of  highest  net  returns,  as  it  simply  de- 


TAXATION   OF  PUBLIC   SERVICE  CORPORATIONS     643 

presses  the  whole  curve  of  rates  by  a  uniform  amount.  In 
short,  it  is  mathematically  impossible  for  a  uniform  gross  earn- 
ings tax  to  work  great  injustice  between  subjects  of  the  same 
class,  except  in  those  exceptional  and  incompletely  developed 
cases  in  which  the  expenses  are  increasing  by  irregular  leaps 
as  the  business  grows.  Stated  in  less  technical  terms,  the 
value  of  the  public  service  enterprise  depends  on  the  amount 
of  gross  earnings  which  the  manager  has  to  conjure  with,  and 
a  tax  in  proportion  to  those  gross  earnings  can  but  little,  if  at 
all,  disturb  the  relative  advantages  which  the  various  com- 
panies may  enjoy.  The  objection  to  gross  earnings  tax  seems 
therefore  to  be  weak. 

On  the  other  hand,  the  advantages  of  the  gross  earnings 
tax  are  many  and  obvious.  The  base  is  an  easily  ascertainable 
fact.  It  is  not  subject  to  bookkeeping  deductions,  nor  can 
it  be  manipulated  or  falsely  reported  save  by  perjury  of  the 
most  pronounced  and  easily  detectable  character.  This  tax 
requires  no  supervision  of  corporation  bookkeeping,  and  no 
interference  with  the  internal  management  of  the  corporation. ' 
The  determination  of  the  amount  to  be  paid  is  a  mere  arith- 
metical computation  which  any  newspaper,  any  citizen,  can 
check  up.  It  does  not  call  for  the  vesting  of  administrative 
commissions  or  officers  with  wide  discretionary  powers.  The 
tax  is  always  in  direct  proportion  to  the  fund  out  of  which 
it  must  be  paid.  In  short,  it  is  safe,  certain,  non-evadible,  4 
inexpensive  in  operation,  adequate,  if  the  rate  be  high  enough, 
and  as  equitable  as,  if  not  more  equitable  than,  any  other  tax 
applicable  to  public  service  corporations.  It  will  yield  a  reve- 
nue which  will  grow  as  the  needs  of  government  grow.  It 
reaches,  effectively,  the  " unearned  increment"  which  public 
service  corporations  enjoy,  without  confiscating  that  part 
thereof  which  the  original  adventurers  in  the  enterprise  are 
entitled  to  under  our  dominant  conception  of  the  rights  of 
private  property.  It  fulfills  the  demands  of  a  fiscal  officer 
who  wants  a  tax  as  effective,  from  a  revenue-yielding  capacity, 
as  possible  and  at  the  same  time  fairly  equitable.  In  passing 
it  may  be  noted  that  lack  of  efficiency  is  sure  to  result  in 
inequity. 

It  is  sometimes  urged  as  an  objection  that  the  yield  of  such 


644  STATE   AND   LOCAL  TAXATION 

a  tax  fluctuates  without  reference  to  the  needs  of  the  govern- 
ment. An  extensive  study  of  this  feature  shows  that  as  a 
matter  of  fact  it  would  not  fluctuate  any  more  violently  than 
to  have  the  property  taxes  actually  levied  on  the  same  classes 
of  corporations,  and  that  as  compared  with  such  taxes  it  grows 
far  more  rapidly  in  revenue-yielding  power.  It  may  further 
be  urged  that  as  any  decline  in  the  earnings  of  public  service 
corporations  is  coincident  with  "hard  times,"  it  would  not  be 
unbecoming  for  the  government  then  to  retrench  its  expenses 
as  private  individuals  are  forced  to  do. 

The  fourth  method  of  taxing  public  service  corporations, 
namely,  by  special  annual  license  taxes,  has  been  so  little 
developed  that  we  have  but  little  experience  to  guide  us  in 
judging  its  efficiency.  It  is  used  in  connection  with  other 
taxes  in  some  Southern  States  as  a  part  of  a  general  system 
of  business  licenses.  The  yield  is  never  adequate,  and  while 
it  may  reasonably  be  used  to  fill  in  the  lacunae  of  some  other 
tax  or  taxes,  it  cannot  be  easily  adjusted  as  a  sole  tax.  It 
is  doubtful  whether  in  the  Northern  States,  which  have  in 
general  surrendered  the  field  of  license  taxation  to  the  local 
governments,  any  revival  of  this  system  would  be  desirable. 

The  gross  earnings  tax  seems  to  be  adapted  to  the  taxation 
of  the  following  classes  of  public  service  corporations:  first, 
all  those  engaged  in  transportation,  of  which  we  have  at  pres- 
ent the  railroads,  including  street  railroads,  the  car  companies 
and  the  express  companies ;  second,  those  engaged  in  furthering 
communication,  the  telegraph  and  telephone  companies;  and 
third,  those  engaged  in  the  production,  transmission  and  sale 
of  light,  heat  and  power.  Incidentally  it  is  peculiarly  well 
suited  to  the  taxation  of  insurance  companies,  but  as  these 
are  hardly  to  be  classed  as  public  service  corporations  they 
fall  without  the  scope  of  this  essay.  It  is  ill  adapted  to  the 
taxation  of  water  companies.  This  fact  becomes  apparent 
the  moment  one  tries  to  determine  a  fair  rate  for  a  group  of 
actual  water  companies.  The  economic  reason  for  this  is 
probably  to  be  found  in  the  fact  that  water  companies  enjoy 
"natural"  rather  than  "capitalistic"  monopolies.  Their 
profits  depend  upon  local  advantages  or  disadvantages,  and 
are  not  governed  by  those  leveling  tendencies  which  affect 


TAXATION   OF  PUBLIC   SERVICE   CORPORATIONS     645 

all  these  industries  into  which  capital  can  more  readily  flow 
when  exceptional  profits  are  revealed.  The  water  company, 
whether  engaged  in  irrigation  or  in  domestic  water  supply, 
is  closely  connected  with  the  land.  The  value  of  its  plant  is 
determined  by  and  contributes  to  local  land  values  in  such  an 
intimate  way  that  the  values  of  the  two  are  both  controlled 
by  the  same  laws.  This  points  to  the  same  method  of  taxa-\ 
tion  for  each,  that  is,  for  land  and  for  water  companies,  and 
certainly  the  gross  earnings  tax  is  not  applicable  to  land.  As 
in  the  case  of  landowners,  so  in  the  case  of  water  companies, 
the  potential  resources  are  often  but  partially  utilized,  and 
a  gross  earnings  tax  would  not  reach  these  unused  resources 
as  a  property  tax  would.  Moreover,  the  case  of  water  com- 
panies is  complicated  by  the  numerous  publicly  owned  plants. 
So  far  as  experience  is  yet  available,  it  is  doubtful  whether 
anything  better  than  the  property  tax  can  be  devised  for  water 
companies.  It  may  as  well  be,  however,  that  cities  and  mu- 
nicipal districts  under  irrigation  would  be  wise  to  collect  a  fixed 
percentage  of  the  gross  earnings  of  water  companies  in  addi- 
tion to  the  property  tax,  this  percentage  being  regarded  not  as 
a  tax,  but  as  part  payment  for  the  sale  of  public  rights. 

The  determination  of  the  rate  of  taxation  which  should  be 
applied  to  the  gross  earnings  of  different  classes  of  corporations 
is  not  so  difficult  as  might  at  first  thought  appear.  We  have 
a  fairly  accurate  idea  of  what  constitutes  a  just  tax  on  prop- 
erty. In  the  United  States  at  large  the  average  for  real  estate, 
the  only  class  of  property  fully  taxed,  is  not  far  from  1  per 
cent  on  the  full  market  value  of  the  property.  For  purpose 
of  illustration  we  may  assume  that  1  per  cent  on  property  is 
a  fair  rate  with  which  to  compare  taxes  levied  on  some  other 
basis.  Should  some  one  else  decide  for  his  own  part  that 
some  other  rate  is  fair,  he  can  easily  raise  or  lower  the  rates 
at  which  we  may  arrive  in  proportion  as  his  "fair  rate 
property"  is  higher  or  lower  than  1  per  cent.  For  purpose 
of  illustration,  further,  our  assumed  1  per  cent  renders  the 
computations  much  simpler  and  the  examples  clearer.  In 
each  of  the  different  classes  of  public  service  corporations 
there  is  a  distinct  trend  towards  a  uniform  ratio  of  net  to  gross 
earnings.  Capital,  in  seeking  investment,  demands  an  average 


646  STATE   AND   LOCAL   TAXATION 

return.  If  investments  in  any  one  line  of  public  service  cor- 
porations, say,  telephones,  yield  an  unusually  large  return, 
more  capital  enters  that  line,  until  its  profits  are  equalized 
with  those  in  other  lines.  So,  too,  if  any  one  line  yields  less 
than  the  normal  profit,  no  new  capital  moves  in  that  direction 
until  its  earnings  there  rise  to  normal.  The  amount  of  capital 
which  any  enterprise  can  carry  is  determined  by  the  net  earn- 
ings. The  proportion  of  capital  to  gross  earnings  is,  therefore, 
what  we  need  to  know  in  order  to  determine  what  rate  of  tax 
on  gross  earnings  is  the  equivalent  of  an  assumed  fair  rate 
on  property.  This  is,  in  turn,  dependent  on  the  ratio  of  net 
earnings  to  gross.  It  is  pretty  well  established  that  the  net 
earnings  of  railroads  approximate  on  the  average  closely  to 
36  per  cent  of  the  gross,  the  same  is  true  of  street  railroads, 
with  a  proper  allowance  for  depreciation  not  often  properly 
charged  in  the  current  accounts  of  such  companies.  In  the 
case  of  express  companies  which  require  a  far  less  proportionate 
amount  of  capital,  the  proportion  of  net  to  gross  earnings  is 
about  15  per  cent  on  the  average.  The  amount  of  property 
is  relatively  small,  especially  if  one  disregard  intangible  prop- 
erty. As  the  United  States  Supreme  Court  found  in  the  famous 
Ohio  Express  Company  cases,  "  $23,400  worth  of  horses,  wagons, 
safes  and  so  on,  produced  $275,446  in  a  single  year."  In  the 
case  of  car  companies,  with  proper  allowance  for  depreciation, 
the  proportion  of  net  earnings  to  gross  is  closely  approximate 
to  that  of  railroads.  For  telephone  companies  the  ratio  is 
a  little  less  than  20  per  cent  and  for  telegraph  companies  a 
little  below  25  per  cent.  The  case  of  light,  heat  and  power 
companies  presents  greater  difficulties  on  account  of  the  rapid 
changes  going  on  in  the  methods  of  production  and  transmis- 
sion which  make  the  rate  of  depreciation  on  the  plant  very 
rapid  and  very  uncertain.  With  no  allowance  for  deprecia- 
tion they  appear  to  earn  60  per  cent  net  on  the  average,  but 
with  proper  allowance  for  that  element  their  net  earnings 
appear  to  average  something  over  33^  per  cent. 

Under  the  system  of  separate  sources  of  revenue  for  the  State 
governments  as  distinct  from  the  sources  of  revenue  for  local 
purposes,  a  plan  which  a  considerable  number  of  States  have 
arrived  at  and  toward  which  othero  are  working,  all  these 


TAXATION   OF  PUBLIC    SERVICE    CORPORATIONS     647 

public  service  corporations  would  naturally  be  taxed  for  state 
purposes  only  upon  all  but  non-operative  property.  This 
is  because  they  are  general,  not  local,  in  character.  Even  the 
street  railroads  are  an  integral  part  of  the  general  transpor- 
tation system,  and  the  light,  heat  and  power  companies  which 
string  their  wires  over  hundreds  of  miles  have  nowadays  no 
single  mere  local  habitat. 

The  questions  connected  with  state  jurisdiction,  the  ques- 
tions of  interstate  comity  involved  in  the  taxation  of  public 
service  corporations,  present  a  peculiar  set  of  difficulties. 
These  are,  however,  no  greater  under  a  gross  earnings  tax 
than  under  a  property  tax,  in  fact  they  are  easier  to  answer 
under  the  former.  •  It  is  easier  to  apportion  the  gross  earnings 
fairly  between  States  than  to  apportion  the  property.  The 
property  can  be  apportioned  only  on  a  mileage  basis  which 
gives  those  States  with  long  miles  of  sparsely  settled  country 
through  which  the  public  service  corporations  operate  an 
unfair  advantage  and  robs  those  of  denser  population  of  reve- 
nue which  is  peculiarly  their  own.  A  gross  earnings  tax  may 
be  apportioned  on  a  mileage  basis  as  is  the  case  with  the  tax 
on  railroads  in  Maine,  or  it  may  be  apportioned  on  the  basis 
of  business  done  as  is  the  railroad  tax  of  Minnesota.  The 
latter  is  decidedly  the  more  equitable  between  States.  But 
if  neighboring  States,  one  densely  populated  and  another 
sparsely  populated,  have  antagonistic  systems  and  the  sparsely 
populated  one  were  the  one  to  adopt  the  straight  mileage  plan, 
it  might  work  a  hardship  on  the  public  service  corporations. 
Sooner  or  later  this  must  be  a  subject  for  federal  regulation. 
The  federal  government  must  either  collect  all  the  taxes  from 
public  service  corporations  engaged  in  interstate  business  and 
apportion  the  proceeds  among  the  States,  or  it  must  lay  down 
set  rules  according  to  which  alone  the  States  may  tax  such 
corporations.  Probably  the  latter  is  the  more  feasible  plan. 
Meanwhile,  we  shall  be  obliged  to  content  ourselves  with  such 
rules  of  interstate  comity  as  our  American  sense  of  justice  and 
fair  play  may  develop.  Such  rules,  if  ever  developed,  will 
occupy,  so  far  as  concerns  the  States  of  the  Union  and  their 
tax  relations  one  to  another,  the  same  place  as  international 
law  between  nations.  So  far  as  public  service  corporations 


648  STATE   AND   LOCAL   TAXATION 

engaged  in  interstate  commerce  are  concerned  the  only  equi- 
table rule  of  " interstate  law"  would  be,  "Let  each  State  tax 
all  the  business  done  entirely  within  its  bounds,  and  such  pro- 
portion of  all  interstate  business  as  the  mileage  of  such  business 
in  the  State  bears  to  the  total  mileage  over  which  such  business 
is  done." 

The  writer  of  this  essay  respectfully  recommends  to  the 
National  Tax  Association  the  proposal  to  the  States  of  this 
rule  as  part  of  a  code  of  "interstate  law,"  and  further,  the 
indorsement  of  a  tax  on  the  property  and  franchises  of  public 
service  corporations  based  on  their  gross  earnings  within  each 
State  as  defined  by  the  above  rule,  as  the  most  equitable  and 
expedient  method  for  the  taxation  by  the  States  of  the  various 
classes  of  general  public  service  corporations. 


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FEB    23  1934 
HIM  11 *935 

MAY   9  1935 
50  1939 


JUN  2  5  1996 

U.C.  BERKELEY 


LD  21-50m-8,*32 


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